Transaction costs the costs of providing for some good or service through the market rather than having it provided from within the firm Ronald Coase

Search and information costs

Bargaining and decision costs

Policing and enforcement costs

4Transaction costs

Three dimensions along which transactions may vary

asset specificity

uncertainty

frequency

5The three main characteristics of the firm

Collectivity of people in an organization

Action by superior-subordinate direction

Continuity over time

6Firms vs. Markets

The firms benefits

specialization in teams

transaction-cost savings

corporate capital formation

morale

The firms costs

shirking

agent misdirection

rent seeking

7The Problem of X-inefficiency

X-inefficiency - the difference between efficient behaviour of firms assumed or implied by economic theory and their observed behaviour in practice.

- the cost that is higher than it needs to be because the firm is operating inefficiently

8Factors causing X-inefficiency

Internal Factors

Poor contracts between principals and agents

Large firms may be difficult to control

External Factors

Diffuse share ownership

Limited threat of takeover

Degree of competition

Barriers to entry

9The Principal Agent Problem

the principal-agent problem - the difficulties that arise under conditions of incomplete and asymmetric information when a principal hires an agent

the agents actions affect the principal's payoff, but they are not directly observable by the principal, or they are not verifiable to outsiders.

The central dilemma - how to get the employee or contractor (agent) to act in the best interests of the principal (the employer) when the employee or contractor has an informational advantage over the principal and has different interests from the principal.

10Theories of the Firm

Theory of Managerial Utility Oliver Williamson

Sales Revenue Maximization Model William Baumol

Maximizing Present Value of the Firms Future Stream of Sales Revenues William Baumol

11Theories of the Firm

Maximizing Growth Robin Marris

- the managerial utility depends on the firms rate of growth

Supply led growth vs. Demand led growth, or

profitability vs. diversification

The principal-agent problem

12The Theory of the Firm

The Integrative Model Oliver Williamson

Integrates the growth maximization model and the profit/sales maximization models and the maximization of the present value of future sales

Max growth max sales

13Theories of the Firm

Behavioral theories - Herbert Simon, Richard Cyert and James March

Firms multi-goal, multi-decision, organizational coalitions

Imperfect knowledge and bounded rationality

Managers cannot meet the aspiration levels of all stakeholders

Managers cannot maximize, instead they have to satisfice

14Stakeholders in the Firm

Owners/investors

Employees

Customers

Suppliers

Distributors

Creditors/banks

The government

Public at large

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